By James Jones | CEO of IRAeXchange.net
I’ve spent a lot of time in and around IRAs and Self-Directed IRA or “SDIRA,” writing books, speeches, and, generally, educating folks on the topic.
Inevitably, when people get a chance to engage with me after a panel discussions or other presentation, they ask questions. Shockingly, they are often CEOs, Fund Managers, and other financial professionals asking questions about a tax-deferred vehicle that, recently, is growing in popularity by leaps and bounds.
I preface this so that you know that questions come from all sorts. With that, I’ll address some of the most commonly asked questions below (we’ll dive into more detail in the next column, I promise.)
A Self-Directed IRA is one that is designed to let the IRA holder invest in alternative assets other than stocks, bonds and mutual funds. Contributions, distributions, rollovers and transfers are treated the same as with IRAs, according to IRS Publication 590. And they are available in Traditional, Roth, Health Savings Accounts, Coverdell Education Accounts, SEPs and Solo-401Ks forms.
Are Self-Directed IRAs new?
No, the Employee Retirement Income Security Act of 1974 (ERISA) established them on September 2, 1974 (see Pub.L. 93–406, 88 Stat. 829). They did so to allow individuals to save money for their retirement in a tax-preferential way. Congress foresaw the coming end to company pension plans.
Pension providers such as banks, brokerage firms and insurance companies smartly shifted their marketing efforts to IRAs which today represent approximately 99% of the $9.2 Trillion retirement industry.
What is the difference between an IRA and a SDIRA?
According to IRS Publication 590, SDIRAs act like any IRA regarding contributions, distributions, rollovers and transfers, and the same is true across different types of IRAs – Traditional, Roth, Health Savings Accounts, Coverdell Education Accounts, SEPs and Solo-401Ks.
That’s where the similarities end. A little-known IRS code, 4975, became the basis and the “bible” for Self-Directed IRA Custodians and investors, defining what was and wasn’t a permissible investment with SDIRAs.
Unlike IRAs, SDIRAs can invest in almost any asset class other than life insurance and collectibles like art, jewelry and baseball cards. Also excluded are S-Corps, as they are a tax pass-through for the self-employed. Life insurance already has tax benefits – it pays beneficiaries tax free. The IRS disallows collectibles because, while they may have been bought for retirement, they can also be for personal use, benefit or enjoyment such as wearing jewelry or hanging art in one’s home. It is this concept of “self-use” or “self-dealing” that the IRS does not allow and, therefore, becomes the basis for IRS rules and restrictions in the SDIRA industry.
Common examples of alternative assets held within SDIRAs include private equities and private placements, promissory notes, mortgages, hedge funds, futures, commodities and precious metals, real estate, LLCs, precious metals, tax lien certificates, crypto-currencies and certain crowd–funding platforms.
Why didn’t my broker/attorney/CPA/realtor tell me about a SDIRA?
In all fairness, it is unlikely that they are familiar with SDIRAs. These represent approximately 1%, or $150 billion, of the $9.2 trillion retirement industry. Every day I explain the mechanics, process and IRS regulations of SDIRAs to advisers, attorneys and CPAs.
Why doesn’t my broker offer SDIRAs? I thought I saw Schwab and Vanguard offering self-directed investing?
The term “self-directed” is commonly used in a different context. Investors may establish self-directed accounts – where they choose and select their own mutual funds and ETFs, for example. This, clearly, is distinct from how I’m using the term – investing in non-publicly traded private assets with a Self-Directed IRA. Traditional brokerage firms do not offer SDIRAs. Their business model is based upon the annual fees for assets under management (AUM), as well as on trading in the investment products offered and markets made. These firms are bound by the advice (fiduciary) they give as it relates to investor suitability, goals and objectives and risk tolerance.
However, those offering SDIRAs are not selling any type of investment offering, nor may they give any investment advice (non-fiduciary). A SDIRA provider basically custodies SDIRAs for IRA holders to invest in alternative assets that the holders select themselves. At the same time, the SDIRA provider offers basic education on IRA and IRS rules and regulations. The margins are thin for SDIRA providers, often under $1,000.00 per year per account; therefore, “self-direction” often means “self-service.”
While I’ve outlined just the most rudimentary facts about SDIRAs, it can serve you well to learn more about this subject and, generally, about how the financial world works. SDIRAs can give you greater control over your financial future – hopefully, a tax–deferred future.
